Getting Warmer: Insurance and Climate Change

by
Will Jones

Globally, the 10 warmest years on record have all occurred since 1998, and the four warmest years on record have all occurred since 2014, according to the National Oceanic and Atmospheric Administration (NOAA).

NOAA research also shows that the last five years have marked the five warmest Septembers on record. The accelerating rise in global temperatures is resulting in significantly warmer oceans, sinking ice sheets, sea level rises and the increased likelihood of extreme weather events, such as wildfires, flooding, heatwaves and hurricanes.

Because the effects of climate change have the potential to cause significant disruption to the insurance industry, prominent members of the insurance industry have started taking climate change seriously.

“Over the last 10 years, we‘ve seen more and more of our peers and competitors move the topic of climate change up to board level,” says Ernst Rauch, Munich Re’s chief climate and geo scientist. “Climate change is now part of companies’ risk management activities.”

Climate change has been on Munich Re’s radar for the past 40 years. The company makes its observations and data publicly available in Munich Re NatCat Service. “In the 1970s, we realized the loss distributions from natural catastrophe events in certain regions and perils had been changing,” Rauch explains. “From then on, we started building up in-house expertise to better understand what climate change could mean as a risk taker.”

In 2017, total economic losses from hurricanes were nearly five times the average of the preceding 16 years, losses from wildfires were 14 times higher and losses from other severe storms were 60% higher, according to Aon Benfield—all of which presents the industry with serious complications.

“The insurance industry is preparing for the effects of climate change, but the problem is how to prepare when data models are based on outcomes from past events,” says Angela Oroian, president and executive managing director, Society of Environmental Insurance Professionals. “We cannot truly know how severe the next natural disaster will be.”

Insurance has a vested interest in measuring and predicting the planet’s changing climatic conditions and has “pioneered modeling of severe weather events so that they can forecast how much to charge for policies,” says David Dybdahl, president of ARMR.Network. “Then, they’re driving what they know through the reinsurance mechanisms.”

In addition to predicting the cost of evolving weather patterns, another dilemma is “trying to get ahead of the cost of severe weather in the current rates,” Dybdahl says. Compounding the issue are “commissioners who might not believe the forecast of increasingly severe weather events” and are therefore “reluctant to implement increased insurance rates across the U.S,” Dybdahl adds. “That’s a challenge for insurance companies because it potentially challenges their solvency.”

The Task Force on Climate-related Financial Disclosures (TCFD), headed by Bank of England Governor Mark Carney and chaired by Michael Bloomberg, founder of Bloomberg LP, identified climate dangers across a range of industries and sectors, detailing three major risks for the insurance industry.

First, the TCFD highlights the physical risks from changing frequencies and intensities of weather-related perils. Second, due to carbon regulation, it warns against the transitional risk resulting from a disruptive decline in asset values of carbon-intensive investments, which could have an impact on overall financial stability. And lastly, the TCFD issues caution regarding an increase in liability risk relating to carbon-intensive companies who could be held liable for their emissions.

Considering the immense danger climate change poses to the industry, insurers have every reason to feel helpless in protecting risks, as well as their bottom line. However, working in their favor is the idea that “the insurance mechanism automatically works—they don’t have to do anything special,” Dybdahl says. “If the insurance mechanism is left to free float, it will make risk allocation calls perfect over time because the cost of the insurance ends up regulating the risk.”

Recently, climate scientists warned that only a dozen years remain for global warming to be kept to a maximum of 2.7 degrees Fahrenheit above preindustrial levels. Beyond that, even a minimal increase will significantly worsen the risks of a warmer planet, according to a UN Intergovernmental Panel on Climate Change, which also reported that the planet is already 1.8 degrees Fahrenheit warmer than it was in the late 1800s.

Greenhouse gas emissions from human activity, such as burning fossil fuels, would need to be cut roughly in half by 2030 in order to prevent overshooting the target and causing serious impact to the planet, the report said. But with pollution from fossil fuels, therein lies the disconnect: “Environmental risk tends to be ignored by the insurance industry because of the effect of pollution exclusions,” Dybdahl explains. “The effective risk governance in the economy becomes uncoupled.”

As long as the pollution aspect of risk governance is taken out of the equation by the fact that “most commercial buildings hold policies with a pollution exclusion,” Oroian says, it will continue to nullify the insurance industry’s “inherent ability to reward safe behaviors and increase the costs associated with risky behavior,” she says. “This will have a huge economic impact.”

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